What is a Land Contract?
A land contract is a method of purchasing or selling a home without going through a bank or lender. They became popular in the late 1970s and early 1980s when interest rates were higher and qualification requirements were much more stringent. Although not as common today, land contracts still pop up from time to time, and they can be a great tool in unique situations.
How does a land contract work?
REALTOR® Chris Silker with Keller Williams Realty says a land contract is essentially a seller-financed mortgage.
“Rather than borrowing money from a lender, a buyer makes payments to the property owner or seller until the purchase price is paid in full,” he said.
In a land contract, the buyer gives the seller a down payment for the property and the seller acts as the bank, financing the balance of the purchase price. The two parties work together to negotiate an interest rate, terms, and conditions, and typically, the seller carries the loan for a fixed number of years.
While the buyer is making payments to the seller, the buyer is considered to have an “equitable title” to the property. Upon satisfying the terms and conditions, including full payment of the purchase price, the legal title is officially transferred from the seller to the buyer.
When is a land contract used?
Silker says land contracts are attractive to buyers who are unable to obtain financing through traditional means.
“Let’s say a buyer has a solid income and adequate savings, but a low credit score and a high debt-to-income ratio due to medical bills,” he said. “He/she may not be able to qualify for a traditional home loan, so a land contract would be an ideal option. However, the problem in today’s market would be finding a seller to agree to it.”
And finding that seller can be difficult. Not only are we in a pretty hot seller’s market, but financing is much easier to obtain these days, and very few sellers would want to take on the financing burden if they don’t have to.
“These contracts are more common in very high-end properties that are difficult to finance, or with investment properties that are in poor condition and won’t qualify for traditional financing,” said Silker.
While you can see the potential benefits from a buyer’s perspective, you may wonder what’s in it for sellers. As Silker mentioned, land contracts can work well for sellers with a distressed property or one with extensive inspection issues that make it ineligible for financing. Also, in addition to accepting a down payment, the seller in a land contract receives a steady flow of income all while earning interest.
On the flip side, the biggest risk for a seller is the buyer not fulfilling his/her contractual obligation. If the buyer defaults on the contract, or fails to make the monthly payments as required, the seller must file a court action called a land contract forfeiture. In this scenario, the buyer gives up the equitable title and all money paid to the seller, and the seller keeps the real estate. However, the forfeiture process is much more involved than, say, the termination of a lease.
Silker says that for both parties there is a higher risk of failure to perform in a land contract because there are so many variables involved. Those variables include things like, who is responsible for property maintenance? Who will cover the homeowner’s insurance? Who pays the property taxes? What happens if the buyer decides not to buy the property? What if there is damage to the home? What happens if the market appreciates or depreciates dramatically?
The myriad of contractual issues and potential hurdles is what makes land contracts much more complex than the standard home purchase. To ensure your financial interests are protected, it’s imperative that you hire a professional REALTOR®, and possibly an attorney, to help guide you through the process.
“A land contract can be a win-win in certain situations, but there is also the chance for some major pitfalls if the transaction isn’t handled properly,” said Silker. “Good communication and full transparency are critical, and that is best assured when both buyers and sellers have competent, professional representation.”
For a list of knowledgeable and experienced, local agents visit the Greater Lansing Association of REALTORS® website at www.lansing-realestate.com